If a fund is 2nd quartile in the venture world but otherwise outperforming other asset classes, then, yeah, like, that could be interesting. If a group is 2nd quartile but they're delivering 2nd quartile returns, well, say deploying, you know, a 1,000,000,000 plus a year, then that is interesting. Do you think the incentives for pension funds in the United States are inefficient? Peter, I've been really excited, really looking forward to the chat. Welcome to the 10X Capital podcast.
Yeah. No. Thanks for thanks for having me, David. Peter, when you were at TMRS, you deployed roughly $1,000,000,000 across managers. Break that down for me. Yeah. So that $1,000,000,000, you know, that was for that that that was specifically in the venture capital category. You know, the the the total amount end up working on there, actually actually ended up being over, 5,000,000,000 in in commitments.
That 1,000,000,000 was split between 7 managers, a mix of, let's call it, like, you know, more software focus groups to biotech from early stage to later stage, end up being diversified across the the, the the spectrum of strategies and sectors. But that's that's not necessarily how I went about building. I I didn't have diversification as the top line goal of of this portfolio. I mean, venture venture is a game of alpha generation.
It's a game of capturing, you know, capturing and getting exposure, being a part of, you know, these these outliers' journeys. And diversification, is kind of at odds. It's it's kind of at odds with that. So, I mean, real really for me, in building that portfolio and filling it out with with those 7 managers, what I was really keying on was, was backing or was looking for and backing artists. What what do you mean by that artist? I might use artist and force of nature interchangeably.
But when when when I talk about creativity and conviction, I'm talking about people, I'm talking about investors that are able you know, that are willing to do things differently from the pack. You know, group you know, investors are actually, you know, willing to take risk that aren't aren't necessarily just looking to, you know, get into the hottest round led by led by Sequoia or or or led by Benchmark.
You know, people you know, these are people with, like, actual differentiated views on, you know, on on the world and and and how to build their firms. You mentioned 7 managers for roughly $1,000,000,000. How did you go about building that book? We had to find managers that were, you know, that that that that had the potential to substantially outperform, the managers in those other parts of the books.
From there though, it it became a task of boiling the ocean, turning over as many stones, as as as I could to find, you know, to to find those 7, during the time at TMRS. The the total, plan was over over $30,000,000,000. Because of that, I mean, the the tail does end up wagging the dog in some cases here, but you do have to find opportunities where where or we we we define opportunities where we could put substantial amounts of capital to work.
We had to we we had to find opportunities where we where where we could put, where we could make $50,000,000 in upsized commitments, to these groups. How did you sequence that? How do you practically build a $1,000,000,000 venture book? I I called it a hub and spoke approach. The the the very first commitment of, you know, of of that process of this program was, it it was it was to a group it was to Foundry. It was doubling down on their on their fund to fund work.
We we created a custom fund with them that, I mean, the the initial commitment was a 100,000,000. It was just going to co invest alongside them. We were able to write a very large check, tow you know, tow our way into the venture world with a strategy that, you know, with with this with this fund to fund strategy that, was inherently derisked.
And it also had these up you know, these these upside notes to it where we could, where over time, the relationships that we were, you know, indirectly backing could become direct relationships of of ours. That foundry fund that we created with them was that, to me, it was it was fee advantage.
There was less, I mean, we we we were able to negotiate, the fees, and there's much less fee drag involved there than with, say, just going to, you know, going to x y z fund funds and committing to their blind pool vehicle. In this case, we had a good idea of what was going you know, what was likely gonna be in this fund, and we also knew that there wasn't going to be a management fee, on on it too, reducing the fee drag up front.
So you invested into their fund of funds with management fees and carry, and then you invested as a coinvest without management fees. Is that correct? Yeah. Yeah. So so we're we're already in Foundry's main fund. We then went to them with this idea and created this separate this separate vehicle, this separate fund that co invested into it co invested alongside Foundry into, the venture funds where they had excess allocation.
And that and that custom that that new customized fund would, didn't have a management fees. But there was an underlying management fee and carry. They were just on the incremental vehicle. There was only carry. Yeah. Correct. But from an investment standpoint, from a portfolio construction, from a governance standpoint, what mistakes did you make on that venture book?
I I almost found like, I I found myself falling into the trap of filling you know, of wanting to fill this venture bucket and, you know, ultimately filling this private equity bucket that we had. But so and most institutional LPs, you know, they they have these strategic asset allocations. And, like, they they pacing models that show, okay, how much do I need to commit in order you know, annually in order to meet that target or maintain that target or or vice vice versa.
And in the case of in the case of TMRS, our our PE allocation had been doubled or the target had been doubled from 5 to 10% around the time we started making these commitments. And so I I just I I felt this inherent pressure to increase the, you know, to to to increase the, the the check sizes, to put more more money out more quickly.
Joshua Berkowitz on the podcast, from a family office, and you said that it's very important to think about the pacing model in terms of how do you make sure that you deploy across every single year, so that you're able to recycle the capital, you know, in year 7, year 8, or or however. His model is he invests roughly a 6th over 6 years. How do you look at institutional pacing models in venture for an institutional LP?
We we look at the growth assumptions of, like, of of what we already have under management. I mean, we look at we make assumptions around again, like, you know, how much capital is going to be called down, over time, how much capital is going to be distributed. But in, you know, in in in this case, and this this gets back to the the tail wagging dog. There there is a pressure to reach, you know, to to reach these target allocations that are set in in a timely manner.
The the most important thing, in in these pacing models is to just like is is to actually, you know, be able to have exposure to multiple vintage years so you're not overexposed to, to just one single vintage or, like, you know, avoid avoiding just being exposed to 2021 venture, for instance. Absolutely. What is the biggest lesson you learned at t TMRS, Texas Municipal Retirement Systems? Making sure the organization is aligned in its goals and how to achieve those goals.
I mean, what what that looks like for an LP really is just that you I mean, is is that the investment team, the investment team and the noninvestment teams within these, you know, within these organizations and the board of trustees as well that that they all that that they all trust what each other is doing, that the investment team has delegated investment authority, but that the investment team is is also keeping the rest of the the organization,
the rest of the stakeholders apprised of how you know, of of what's going on. Again, it's it's governance. It's it's alignment. It's it's trust. You mentioned that you managed $5,000,000,000 at TMRS. Where were the other $4,000,000,000 invested? That was going into other private equity and private equity oriented type of strategies.
So buyouts, growth equity, special situations, which was a catchall for group for for for for strategies, for managers that didn't quite fit the private equity bucket neatly. Let's talk about governance. We talked about our our friend at State of Wisconsin Investment Board. They got the governance right and that they trust their investment staff. We just saw recently of investment to Bitcoin and crypto as an example. Tell me about governance and how that leads to returns for LPs.
There's all sorts of governance models that you could say, like, range from again, like, you know, delegation, you know, delegation forward to being, you know, to on the other end, like, no delegation, partner you know, working more with fund to funds and relying more on consultants. The governance, you know, and you know, of of these more forward thinking groups, it again, like, it it relies heavily on on delegation.
That is the investment team being able to being able to invest the way, you know, the the way that they want to, the way that they see fit, and to do so, again, like, with with the trust of of of the rest of the organization. I mean, what that what that looks like in practice is that, you know, typically typically comes down to, like, a matter of size with, you know, with investments.
As long as as long as the potential investment recommendation is below, say, a certain percentage of the total funds, then the investment team has full discretion. Again, that delegated investment authority to, you know, to to invest in how they how they see fit. Not every not every LPs like that.
I mean, you you'll you'll have some firms or some organizations, that have to take every one of their investments, you know, to a board of trustees for approval, or they might, you know, they they might need sign off from a consultant, or or or they may just rely on fund to funds to make all their all their investments for them. I mean, those are all examples of where where where there isn't delegated investment authority, where the governance model, isn't isn't really built on on trust.
We were talking offline about the incentives for LP consultants, how there's misalignment between principal and agent. Tell me about the incentives for LP consultants. Consultants, I mean, they're, I mean, they're they're typically paid on on a retainer on a, you know, an annual or multiyear contract of of some sorts.
I I haven't heard of consultants being paid with, incentive comp, or or carrier or some, you know, so so so, again, like, some some form of incentive to, you know, to drive high upside type outcomes. The incentives are instead, again, like, you know, not to not to get fired to keep the contract, going. And, I mean, again, like, that's, like, like, that that that's that's an inherent misalignment. I mean, it's it it it it illustrates just like that.
Illustrates again like the principal agent problem. The goal is to continue the contract, to not get fired. They'll lead consultants, you know, usually recommending, like, you know, groups that aren't emerging managers. Go into these more stop shop options after, after the alpha has really been generated. So, again, like, it's yeah.
Like, it's it's one of those reasons why emerging managers have a, you know, have a a more difficult time raising than established firms, with long multi fund historical track records. They're I mean, they're they're they're right in the crosshairs of a principal agent problem that, that that they may not even know about. You oftentimes hear venture capital is an access class.
Are there LPs that are self aware that are continuing to invest in the asset class that know that they're getting exposure to 2nd quartile or even 3rd quartile funds? There has to be. Yeah. There there's only there's only so much capacity available for LPs that you're going to have to you're going to have to find other, you know, other other groups to, you know, to commit your capital to.
If again, like, if you wanna be in venture, like, you're like, you're going to get naturally pushed to, you know, to groups that may have historically underperformed. I mean, yeah, like, the quantitative story may show that this group has historically underperformed, but under the hood, there might be there might be green shoots. There might be some sort of the the there yeah.
There there there might be a new strategy or a new team, you know, coming forth from, you know, from this historically underperforming firm that makes it actually makes it interesting to, you know, to, to to back. Is there a rational reason for LPs that can't access top quartile to invest in 2nd quartile or median performing venture funds? Is there a financial rationale for that, or is it purely just to check the box and make make their ICs happy?
If a fund is second quartile in the venture world, but outperforming, you know, otherwise outperforming other asset classes, then, yeah, like, that that that could be interesting. If a group is second quartile, but they're doing but but they're delivering second second quartile returns whilst while, say, deploying, you know, a 1,000,000,000 plus a year, then that's, like, that that that that is that is interesting.
I went to my my mentor who was setting up a $1,000,000,000 single family office, and he asked me what he should do. And I said, you should go to all the top funds inside letter hire Carrie. What do you think about that? That's one way you get access. Have you ever seen that? I no. No. I've I've I've never I've never seen that. A public institution could could never like, they they they can never do that. The like, the the investment team would get would get raked over the calls.
I mean, in in in but it's one way to get immediate access day 1. I I imagine most most investors, most GPs would would take that offer. Speaking of incentives for pension funds, do you think the incentives for pension funds in the United States are inefficient? Yes. Many public funds, you know, don't incentivize their investment team. I mean, the the the team itself, the teams in these cases, they care about not getting fired.
But there's no incentives to, like, take a risk, walk, you know, walk to the edge and find turn over the stones and find an interesting opportunity as a higher likelihood of underperforming than, you know, a $10,000,000,000, bio fund but could deliver, you know, multiples upon multiples upon multiples of, you know, better bit better return. I think the Canadian pension funds are much closer to seems to be principal agent alignment.
And the way that they do it is they pay 7 figure, salaries to the very best in class and the top people. And those people typically would have gone on the GP side. They'd they'd go on the LP side. And there's a lot of research and a lot of evidence that that system is is working really well for the Canadians. Yeah. If you're running a pension fund, let's say you were CIO, how would you go about attracting and retaining top talent? Well, I mean, you you you hit on it. You you just hit on it.
You know, it's following, you know, whether, you know, that Canadian model or the or or or the sing Singapore, you know, public sector model. If you wanna build a strong cohesive team that isn't going to be constantly worried about jumping or get constantly worried about their own compensation growth or their own skill set growth, then you just have to pay them, and compensate them really, you know, really well. We'll get right back to the interview.
But first, to stay update on all things emerging managers and limited partners, including the very latest data on venture returns and insights on how to raise capital from limited partners, subscribe to our free newsletter at 10xcapitalpodcast.com. That's www.onezerox capitalpodcast.com. If you could change one thing about the investment management industry, what would that one thing be? It would be set towards solving that alignment issue.
It's like, giving the investment teams at every one of these organizations, the the delegation, the authority, the discretion to do their jobs, to invest. You know, there there's all sorts of strings attached, you know, to, you know, to to to delegation, you know, to these governance models.
And, you know, just just being able to put the trust back in place with the investment team, you know, to allow them to invest without, you know, without interference from all sorts of other, stakeholders, I I think would go a long way towards, you know, to towards, you know, delivering great financial outcomes, to making, you know, to making staff feel more empowered, to reducing the the that revolving door that we're talking about, even. But again, it it comes down to trust.
It comes down to it it comes down to, people, you know, people trusting the investment team and the investment team trusting each other. We were speaking offline about LPGP relationships. What is the best way for LPs and GPs to build a relationship with each other? It just comes down to, it it just comes down to time. We We all went through COVID years.
I mean I mean, we we we all commit to groups where, you know, we, you know, where where we spent more time with them, you know, over over Zoom or over the phone versus in in person.
But, again, that that that that in person time is is is just so important to, you know, to to getting to know, to to getting to know these people, to really, like to to really start building the mosaic that is, you know, the that that that is your investment thesis for, like, why why you're going to partner with them for for for years to come. Building real relationships, for first and foremost. Peter, it's been a fascinating interview. I've learned a lot, and I know the audience has as well.
What would you like, to shine a light on for the audience? I spent most of my career, on on on the private investing side, again, but mostly as an LP, of of course, as we've as as as we've touched on today. And during that, you know, during that experience, you know, through through that 5,000,000,000 or so of, you know, of of of commitments that that that I've been able to make.
I've I've come to realize again, it's important to look for look for these investors that are playing at the intersection of creativity and conviction. It's important to look for these investors that that are artists, who, you know, who who treat their work with this duty and this feeling of care. Absolutely. Well, it's been really great to chat, Peter. I look forward to meeting, I'm in Austin often, so I look forward to sitting down there or in New York City.
Yeah. Absolutely. Thanks, Peter. Thanks, David. Thanks for listening to the audio version of this podcast. Come on over at 10xCavill podcast on YouTube by typing in 10xCavill podcast into youtube.com and clicking the subscribe button. On the YouTube version of this podcast, you could see the graphs, visuals, and key takeaways that accompany every episode.